California Irrevocable Trust Law: What You Must Know

What is an Irrevocable Trust?

Many people have heard of revocable trusts, but far fewer are familiar with the concept of an "irrevocable" trust. The meaning of the term "irrevocable" is fairly clear – it simply means that the trust is not subject to modification by the person who created it. When it comes to a revocable trust, the grantor (the person that created the trust) is also the trustee. As the trustee, he or she has full control over management and investment of assets while he or she is alive. Furthermore, when the grantor dies, the original trust will become irrevocable (as long as the terms of the trust do not provide otherwise). As an irrevocable trust, the terms of the trust will remain in place until they are specifically amended under the relevant provisions of law. Revocable trusts are useful for people who want the flexibility to change or modify the terms of a trust.
In contrast, an irrevocable trust cannot be modified once established. The irrevocable trust is a separate entity, and the grantor is often not a beneficiary. Therefore, the grantor has no control regarding changes to the trust. The terms of the trust cannot be changed without judicial approval or consent of all the beneficiaries. However, the trust may provide for a limited power of appointment which allows the trustee to modify the trust under certain conditions .
Irrevocable trusts are commonly used for estate planning. One important purpose of an irrevocable trust can be to lower the taxable estate. This is often used when a person wishes to leave part of their estate to charity, both for gift tax planning purposes and to benefit a charity at the same time. Other uses can include getting assets away from the reach of creditors, or protecting government benefits.
Even though the general rule about irrevocable trusts is that they cannot be modified, section 15403 of the California Probate Code does allow the trust document itself to delegate authority to a trustee allowing the trustee to modify the trust with judicial approval or consent of all the beneficiaries. In this way, if a need arises for modification, it may be accomplished as long as the action requested is not contrary to any material purpose of the trust. Furthermore, the legal rules regarding "decanting" pursuant to section 18200 et seq. of the California Probate code may allow certain modifications to an existing trust that are consistent with the terms of the original trust.
The definition and legal framework of irrevocable trusts can be complicated, and a thorough discussion of their intricacies is well beyond the scope of this post. But this should provide a basic overview of the concepts.

The Advantages of an Irrevocable Trust

Asset protection is one of the primary advantages of creating an irrevocable trust. Since the grantor has no control over the assets that are placed in the trust, creditors cannot reach these assets. Some people may think that a revocable living trust offers the same level of asset protection; however, because the grantor still has the power to revoke the trust, creditors can reach the assets in a revocable trust.
Tax advantages are another reason why establishing an irrevocable trust may be beneficial. Assets that are placed into an irrevocable trust may no longer trigger certain taxes. For example, irrevocable trusts are generally excluded from estate tax since the grantor does not have control over the assets and no access to the income generated by the trusts. This means that, if managed properly, the trust assets are not included in the grantor’s estate for tax purposes when he or she dies. In addition, certain irrevocable trusts will omit assets from being included in gift and GST tax, reducing exposure to both gifts and estate tax.
Privacy is another reason to set up an irrevocable trust. Generally, not all information about irrevocable trusts is disclosed in the probate court filings, which offers a level of privacy that would not be available in a revocable trust that would likely be filed with the court.

Essential Aspects of California Irrevocable Trust Law

A California IRREVOCABLE Trust is an estate planning tool that is created by a Settlor and Trust maker to address specific goals. Typically, it would be used to pass wealth to heirs with potentially efficient and flexible distribution to avoid probate and minimize taxes. The rules which govern the formation and operation of a California IRREVOCABLE Trust are found primarily in the California Probate Code Sections 15000 to 19431.
Trust Creation
California Probate Code Section 15000 sets forth the requirements for the creation of an express IRREVOCABLE Trust. A settlor may create an IRREVOCABLE Trust for any valid purpose (i) as long as the purpose is not illegal, (ii) the right of the settlor to transfer property to an IRREVOCABLE Trust is not limited by the terms of a contract or court, (iii) the Trust is not in contravention with public policy, and (iv) the Trust is created by the settlor in writing or by the settlor’s conduct by transferring property to the Trust or under the terms of a pour-over will. If the IRREVOCABLE Trust is created in the trust maker/settlor’s will, it is known as a testamentary trust. If the IRREVOCABLE Trust is created out of the trust maker/settlor’s will, it is known as a living trust or inter vivos trust. See, California Probate Codes Sections 6300, 6302 and 6303. In the case of wills, the IRREVOCABLE Trust goes into effect upon death. Whereas, a living trust is effective immediately upon its creation, but not effective until funded by the trust maker/settlor’s personal property or real property.
Trust Terms
California Probate Code Section 15120 states that a Trust may place restrictions on the discretionary powers of a trustee. However, the terms of the Trust cannot prohibit the following: (i) the appointment, powers, duties or compensation of a trustee or successor trustee; (ii) the revocation of a trust after the death of a settlor; (iii) the appointment of a successor under Probate Code Section 15670 to a trustee who declines to serve, is not qualified or is not reasonably available, including a deemed resignation of an existing trustee; (iv) the appointment of a person to fill a vacancy in the office of trustee; (v) a release of trust property for less than adequate consideration; (vi) an appointment of a successor trustee by a person holding a power of appointment under California Probate Code Sections 630-648; (vii) a release of or disclaimer of a power of appointment; (viii) a limitation on a trustee’s authority to act without the consent of a cotrustee; (ix) the appointment or change in appointment of one or more cotrustees; or (x) a modification to the trust upon agreement of the trustee and all beneficiaries who have reached the age of majority or are emancipated minors. See, California Probate Code section 15120(c)(1).
Trustee Obligations
Under California Probate Code Section 16002, trustees must administer the Trust according to the terms and purposes of the Trust instrument or the requirements of the statutory law. Further, the trustee must be loyal to the beneficiaries and avoid self-dealing throughout administration of the Trust. California Probate Code Section 16002(a). The duty in California Probate Code Section 16002 presumes an understanding of the intent of the Trustmaker/Settlor regarding the administration of the Trust. The Court may also consider the language of the Trust instrument to determine if the Trustmaker/Settlor intended the trustee to act differently from the expressed duties found within California Probate Code Section 16002. In addition to being loyal, the trustee must also act in good faith when administering the Trust. California Probate Code Section 16002(d). The California Court of Appeal in Shultz v. Collins (2018) 22 Cal.App.5th 455,463 found that the trustee must "act within the scope of [its] powers" and "exercis[e] that power in good faith," and "in furtherance of the purpose of the trust." An unexcused failure to exercise the powers of the trust will make the trustee liable to the beneficiary for loss or profit which would otherwise have accrued to the beneficiary. California Probate Code Section 16009(b). Trustees must also report and account for the Trust property, the amount and character of the income, receipts, disbursements, transactions and other acts requiring an accounting and their states of administration as required under California Probate Code Section 16062 for the protection of the beneficiaries. California Probate Code Section 16062. Lastly, like all trustees, IRREVOCABLE Trust trustees will want to consider any potential liability to third parties for the acts or omissions of the trustee. California Probate Code Section 16233 contains the "powers of attorney statute" for Trusts and states that an agent under a power of attorney owes its principal and those who enforce the power of attorney "the duties [of] loyalty, care, and confidentiality and shall act in good faith and due care . . .." See, Probate Code section 16230 (a). California Probate Code Section 16233 provides that a trustee may be liable to a third party for the damages that a third party may incur as a result of the trustee acting outside of the power of the trustee. If the third party is acting in good faith and relies on instruments signed by the trustee that purport to grant the trustee authority to perform an act, the good-faith actions of the third party will not create liability for the third party. See California Probate Code section 16233(b)(c). The core take-away is that a California IRREVOCABLE Trust must fulfill the purpose for which the Trust was created and be administered according to California law. Also, a California IRREVOCABLE Trust is more susceptible to modification by the trustmaker/settlor and may contain more recent statutory limitations than other forms of trusts.

Establishing an Irrevocable Trust in California

Setting up an irrevocable trust in California isn’t particularly complex, but it does involve making some important decisions that shouldn’t be taken lightly. You will need to choose a trustee, draft the trust document, and, most importantly, fund the trust.
Appointing a trustee
The presence of a trustee is essential to any living trust. Typically, the person who creates the trust is its initial trustee. But, as the name "irrevocable" implies, once you’ve transferred property to your irrevocable trust, you’re no longer legally allowed to act as trustee, even if you also created the Trustee. Your trust may include provisions naming a successor trustee who will run the trust when you’re gone. Or, the trustee can be selected after you’ve passed away (or have become incapacitated), either by a separate instrument or by a court.
Drafting the trust document
Trusts are generally revocable while a person is alive, so if you haven’t laid out a clear structure for your future trustee, or have made a mistake in your planning, it might not be clear whether or not the trust should be kept in effect, or if you really want to do anything at all.
It’s important to be very careful with your wording. One way to minimize any potential issues later on is to work with a trust planning specialist to get the most out of your document. Note that trust laws may vary from state to state, and irrevocable trusts are even more closely regulated than their revocable counterparts, so especially for this type of trust, you really should reach out for professional help.
Funding the trust
You can’t simply sign a trust and instantly designate several significant assets as belonging to it. To make sure your trust is valid, you must take another step: transferring property to it.
To do this properly, you will need to provide either a signed Deed or Assignment of Property in order to change the legal owner of the asset, and the name (or names) of the people created the trust and are now transfer the property. Keep in mind that specific rules must be followed when it comes to transferring real estate, including the use of a signed deed, or the property won’t be legally considered part of the trust.
Some assets, such as real estate, stocks, and savings, can be transferred as-is. For bank accounts, you may need to have the trust listed as the account holder on the relevant documents. Certain life insurance and retirement plans may allow you to name your trust as a beneficiary, which would ensure that funds go directly to it upon your death.

The Tax Consequences of an Irrevocable Trust

Tax Consequences of an Irrevocable Trust
Because the trust assets are distributed to beneficiaries, a trust can lower the estate tax burden for a deceased Grantor. There may be tax consequences a Trustee and beneficiaries must be mindful of. An irrevocable trust has its benefits and disadvantages. For example, with an irrevocable life insurance trust, the Trustee will be responsible for a beneficiary or beneficiaries that have a vested interest in the trust. Tax consequences also need to be considered when the assets are distributed from the trust. The tax obligations could be the responsibility of the Trustee or the beneficiary. When distributions are made from a trust with a sale or exchange of property, there will be potential capital gains tax consequences. The Trustee should be prepared to handle any tax liability on behalf of the trust, or obtain proper documentation from beneficiaries that they are responsible for their share of tax liability. A trustee (not a beneficiary) must file a tax return, IRS Form 1041, and send a Schedule K-1 to the beneficiary who is being taxed on income received. When a beneficiary has enough income reported, she/he generally will pay personal tax on those dividends. In settling the estate and making the distributions, the Trustee should consider the tax ramifications of the sale price. The Trustee may want to get an opinion from a legal tax professional. Although an exempt organization is not subject to income tax, it may owe tax on Unrelated Business Income (UBTI) that exceeds $1,000. If the trust owns real property or real property outside of California, the Trustee should file appropriate tax returns and pay taxes on behalf of the trust with a California Franchise Tax Board (FTB), California Department of Tax and Fee Administration (CDTFA) and/or Board of Equalization (BOE). Tax return filings depend on how the trust is registered, if recognized as a foreign business and what activities the trust is conducting. The trust tax year may be different from the Grantor’s year. The trust needs to report on a 701 Form, for an irrevocable trust, and the tax return is due to California FTB by the 15th day of the fourth month following the close of the tax year. The tax return filing deadline may differ from the federal tax return filing deadline.

Common Issues and Misunderstandings

One of the biggest challenges that individuals face when dealing with California irrevocable trusts is navigating the complex laws and understanding the restrictions that they impose. As mentioned previously, even though an irrevocable trust cannot be modified or terminated without the permission of the grantor and all trust beneficiaries, there are still several actions that can be taken to make it more manageable, should the need arise. One of these actions is petitioning the Probate Court pursuant to the law of cy pres. This type of petition can allow for the trust to be amended or terminated by proving that the original terms of the trust can no longer be carried out because the purposes of the trust can’t be accomplished because of circumstances not anticipated. The attorney must explain the reasons for the cy pres action to the Court , and successfully convince the Judge that the purposes of the trust can’t be fulfilled. Some of the most common misconceptions about California irrevocable trust law include: •That a California irrevocable trust cannot be modified AT ALL. As we previously explained above, that is simply not true, as long as all of the purposes of the trust are being fulfilled at the time of modification, the Court can allow a trust to be modified. •That a California irrevocable trust cannot be terminated AT ALL. A California irrevocable trust may not be terminated either by the wishes of the settlor, or by the Probate Court if the terms of the trust have not been completed. However, if the purpose of the trust can no longer be achieved, a cy pres action can allow the court to terminate the trust and redistribute the trust estate to other beneficiaries.

Amending or Revoking an Irrevocable Trust

In California, an irrevocable trust can be modified or terminated under certain circumstances. Trusts are generally subject to modification or termination at any time by the settlor and all of the beneficiaries, unless the right to modify or terminate a trust is expressly revoked by the reference document in California Probate Code section 15402. California Probate Code section 15403 outlines the circumstances under which a trust may be modified due to change of circumstances which affect the purposes of the trust. The trustee of a trust can also have the trust modified or terminated under California Probate Code section 15403 if such modification or termination is needed to carry out the purposes of the trust or to move the principal or income of the trust to new trustees.
Any provision in a will or codicil which prohibits, or in any manner restricts, exercise of the right of revocation, modification or termination of a trust is against public policy and therefore void and unenforceable. California Probate Code section 15406(e). If a trust may not be modified or extended, due to the specificity restrictions in the trust document, the trust can be decanted to a new trust under California Probate Code section 163.3, if the settlor and all beneficiaries agree to the new changes to the trust. If the trust is irrevocable, such as a CRT, a CRUT or CRUT, a special proceeding brought by the trustee or other interested person to decant a charitable remainder trust or split-interest trust under California Probate Code section 18200 may be required. Decanting occurs when the decanting trustee distributes the principal directly to one or more new trusts formed and funded by the trustee. Under California Probate Code section 15403(g), if the trustee is not the beneficiary of the trust and if the trustee wants to make a trust modification, the trustee must petition the court to authorize the change. To modify the irrevocable trust under California Probate Code section 15404, the modification must meet these requirements:

Be in the best interests of the beneficiaries
Protect a beneficiary’s right to an elective share, if he or she has that right under California law at the time of the proposed modification or termination
Protect a beneficiary’s right to distribution from the principal of the trust if he or she has that right under California law at the time of the proposed modification or termination
Affect the administration of the trust.

Selecting a Trustee for an Irrevocable Trust

As with all trusts, choosing the right trustee (the individual or corporate entity that manages the assets of the trust and is responsible for carrying out the terms of the trust) is critical to a successful estate plan. In California, an irrevocable trust may be created by any person competent to contract. The grantor may provide for its own appointment as trustee or for the appointment of a bank or trust company authorized to accept a trust as trustee. When appointing a trustee, whether as the grantor or as the beneficiary of an irrevocable trust, there are several important considerations.

Consider appointing a licensed, independent third party professional or financial institution rather than a family member.
Remember that a corporate trustee will expect to be paid for its services.
If the beneficiary is able to remove the trustee, first consider whether the beneficiary will exercise that right to the detriment of the grantor’s undivided interest in the trust.
If a bank or financial institution is chosen, make sure that it has a strong record of stability, whether publicly or privately held.
Current height of interest rates: this is not suggested to be the primary factor in making the choice, but instead one of several to take into consideration.

Final Thoughts: Is an Irrevocable Trust Right for You?

The world of what people believe about irrevocable trusts and how they really work can often be very different. It’s critical to engage in the discussion with your estate planning attorney to identify whether such a drafting technique as a California Irrevocable Trust is appropriate for your individual circumstances. While we have tried to cover many of the basic issues surrounding the creation of an irrevocable trust and some of the important issues that one needs to consider when drafting such , this blog does not – and cannot – cover every aspect or every nuance of this complex area of law. The foregoing has just covered the basic points. But the complexity of California Trust law on this subject means that you have to be careful, and make sure that you and your attorney discuss on an in-depth level how to best plan for the passing of your estate.